Question

“I know headquarters wants us to add that new product line,” said Dell Havasi, manager of Billings Company’s Office Products Division. “But I want to see the numbers before I make any move. Our division’s return on investment (ROI) has led the company for three years, and I don’t want any letdown.”

Billings Company is a decentralized wholesaler with five autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company’s Office Products Division for the most recent year are given below:

Sales	$	21,750,000
Variable expenses		13,731,600
Contribution margin		8,018,400
Fixed expenses		6,025,000
Net operating income	$	1,993,400
Divisional operating assets	$	4,338,800

The company had an overall return on investment (ROI) of 18.00% last year (considering all divisions). The Office Products Division has an opportunity to add a new product line that would require an additional investment in operating assets of $2,126,350. The cost and revenue characteristics of the new product line per year would be:

Sales	$ 9,350,000
Variable expenses	65% of sales
Fixed expenses	$ 2,560,500

Required:
1.	Compute the Office Products Division’s ROI for the most recent year; also compute the ROI as it would appear if the new product line is added. (Do not round intermediate calculations. Round your Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

        

2.	If you were in Dell Havasi’s position, would you accept or reject the new product line?
	Accept Reject

3.	Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
	Adding the new line would Increase the company's overall ROI. Adding the new line would Decrease the company's overall ROI.

4.	Suppose that the company’s minimum required rate of return on operating assets is 14.00% and that performance is evaluated using residual income.

a.	Compute the Office Products Division’s residual income for the most recent year; also compute the residual income as it would appear if the new product line is added. (Enter your Minimum Required Rate as a whole percentage (i.e., 0.12 should be entered as 12).)

             

b.	Under these circumstances, if you were in Dell Havasi’s position, would you accept or reject the new product line?
	Accept Reject

Answer 1

income on new line
contribution (9,350,000*35%)=					3,272,500
less Fixed expense					-2,560,500
Net operating income					712000
1,2&3)				present	new line	total
	Sales			21,750,000	9,255,000	31,005,000
	Net operating income			1,993,400	712,000	2,705,400
	operating assets			4,338,800	2,126,350	6,465,150
	margin			9.17%	7.69%	8.73%
	turnover			5.01	4.35	4.80
	ROI			45.94%	33.48%	41.85%
	where margin = net operating income/sales
	turnover = sale/average operating assets
	ROI = margin *turnover
4)	Reject
5)	Adding the new product line would improve overall ROI
6)	Residual income = net operating income -(average assets *min rate or return)
				present	new line	total
	operating assets			4,338,800	2,126,350	6,465,150
	minimum required return			14%	14%	14%
	min net opeerating income			607432	297689	905121
	actual net operating income			1,993,400	712,000	2,705,400
	min net operating income			607432	297689	905121
	residual income			1,385,968	414,311	1,800,279
b)	Accept